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(16:00 MARKET UPDATE) European stock markets are convulsing, swinging back from earlier highs after having rallied for most of the day, as investors begin to fear over the prospect of a hung parliament in Italy.

Italy’s FTMIB index pared back most of its gains, having been nearly 4% higher earlier in the day on the prospects of Pier Luigi Bersani’s centre left party winning the Italian elections in both the lower house and senate.

Projections published later in the afternoon though showed that Silvio Berlusconi’s centre right party is heading for victory in the senate.

A hung parliament or victory by Berlusconi’s anti-austerity party is seen as a grave risk to eurozone stability. Full official results are not expected until late tonight.

Britain’s FTSE 100 also lost its earlier gains, to trade flat at 6,340. US markets were flat.

The euro pared its gains against the US dollar to trade flat at $1.31.97

The British pound remained sharply lower against the euro, down 1.1% at 1.1431 after Moody's downgraded the UK credit rating on Friday (see report below)

(12:30) Pound tumbles but FTSE rises after Moody's move

Currency markets were in turmoil as the pound slumped against the euro in response to Moody’s historic downgrade of the UK’s credit rating and the yen yo-yoed at the prospect of two new ‘doves’ in charge of the Bank of Japan.

Equity markets, however, shook off weaker-than-expected economic figures from China. The FTSE 100 advanced back towards the 6,400 level it briefly captured last week with a 42 point or 0.6% rise to 6,377.

China: lunar impact

HSBC’s China flash manufacturing PMI (purchasing managers index) for February came in at 50.4, down from 52.3 in January and less than the consensus forecast of 52.2. In PMI surveys a reading of 50 separates growth from contraction. However, analysts blamed the impact of the lunar new year holidays and said China’s steady expansion was probably continuing.

In Europe the FTSE Eurofirst 300 also gained 0.6% or 6.5 points to 1,172 as Italians went to the polls for the second day in the general election with nervousness over an inconclusive result apparently diminishing.

In London, copper miner Antofagasta (ANTO.L) led the FTSE 100 higher, up 40p or 3.7% to £11.24.

Banks up, Pearson down

Royal Bank of Scotland (RBS.L) surged 12.3p or 3.6% to 357.3p on reports the state-owned bank will announce plans to sell its US arm RBS Citizens.

Barclays (BARC.L) gained 10.5p or 3.4% to 317.5p as minority shareholders in South Africa’s Absa backed plans to merge the banks’ African operations.

Pearson (PSON.L) tumbled 68p or 5.6% to £11.48 after the Financial Times owner and educational publisher, warned difficult advertising markets and lower government spending would hit its publishing and schools businesses.

New chief executive John Fallon launched a £150 million restructuring effort which he said would drive faster growth from 2015 but insisted he would not sell the FT Group.

Reckitt Benckiser (RB.L) fell £1.58 or 3.5% to £43.58 after the goods manufacturer’s failed to convince the US drugs regulator to impose tougher packaging standards on generic rivals to its heroin addiction treatment Suboxone.

Analysts at Investec downgraded the shares to ‘sell’ from ‘hold’ after their strong recent run and because Suboxone represents 15% of group profits.

Pound takes another pounding

But it was the plight of the pound that grabbed the limelight, slumping 1.4% to a 16-month low 87.70p to the euro after Moody’s cut Britain's AAA rating by one notch to Aa1. This is the UK's first ever downgrade and reflects the agency's view of the weak state of the economy.

Sterling recovered against the US dollar, however. After falling to $1.5073, down 0.3% from $1.5124 late last week, it reversed its losses to trade at $1.5147.

The pound has tumbled from $1.6176 against the dollar this year, its fall exacerbated by last week's revelation that the governor of the Bank of England had voted for more quantitative easing or 'money printing' to stimulate the economy.

The big question is whether the downgrade will spark a further round of selling this week.

Paris Anand, head of pan-European equities at Fidelity, said: 'The impact on sterling could be modest from here with the market having arguably moved ahead of the announcement. However, the greater impact could be the evaporation of the fledgling optimism that the economy may be about to turn given improving employment numbers, recovery in house prices and the prospect of moderating austerity.'

UK government bonds held steady, however, with benchmark 10-year gilts trading at a price of 96.72 and yielding 2.13%. Gilts moved last week in anticipation of Moody's action.

See AAA Q&A for more explanation of the significance of the UK rating downgrade

Bank of Japan awaits 'deflation busters'

Meanwhile, after sliding to a new low of 94.77 yen to the dollar, Japan’s currency also recovered to trade 0.7% higher at 93.81 yen to the dollar.

The volatility was caused by growing speculation that Japan will name two ‘deflation bashers’ to head up the Bank of Japan.

Haruhiko Kuroda, president of the Asian Development Bank, is said to become the next governor of the Bank of Japan. Like other leading candidates for the post Kuroda has expressed his support for a more aggressive monetary policy than the current governor Masaaki Shirakawa.

Kikuo Iwata, an academic who supports unorthodox measures such as quantitative easing, is also being lined up to be one of his deputies, according to reports. Their arrival would herald more attempts by authorities to drive down the value of the yen to boost inflation and corporate profits.

Isn't it about time we realised we can no longer afford to be one of the world's policemen, and that charity very much begins at home. The fact we now have food banks for our own people and yet still give aid to countries like India is barmy.

The time hascome to give up on Trident as an unafforable item on the defence budget. The MAD principle from the cold war days is redundant. We can still use our nuclear powere submarine attack fleet to seriously hurt any realisitic enemy of today.

Foreign aid to the right people and delivered by the right people to the points where most needed is worthwhlle; Unfortunately to much food and money ends up in the hands of crooked politicians and blackmarketeers. Birth conttol in these impoverished countries need to be integrated into foreign aid programmes. No nuclear armed country should be included in British foreign aid programmes.

The foreign aid budget is not as simple as just handing out cash, we get a return in two ways. One is as a sweetener for overseas contracts, the other is that carefully spent it can avoid military action later on if it helps a country develop. Just think about the cost to us all of the Somali pirates caused by severe poverty in that part of Africa (it's their only industry!). It's difficult to quantify but diplomacy and targetted aid is a damn sight cheaper than warfare.

Also we need to distance ourselves from some of the insanities of the Socialist EU. At the moment we are the 'go to place' for the sick and scroungers of the world to sneak in and live, claim family/lived here long so they can benefit.

Those that bring in relatives should be responsible 100% of their keep/hospital bills/housing etc (including families started), forever. Deportation automatic for criminals other than for minor infractions. As most come through France, that should be the destination for those that used that route.

So you are in favouring of paying a clique Somali pirates not to hijack ships on the high seas, holding them and their crews for an unlimited period until huge ransomes are paid; with the millions received shared not amongst the general population but kept by the few to live a life of luxury in grand homes bought in Kenya. Somalia is failing due to it being controlled by Islamic fundamentalists, whose goals will not be changed by the offer of money. If its pirate community were dealt with accordingly by an internationally co-ordinated gunboat policy , they would soon stop their trade. The millions spent on protecting the international waterways from pirates could then be used to feed the starving millions in the world. Appeasement of criminals never works. Sweetners for contracts are nothing to do with the generally accepted meaning of foreign aid, At best, sweetners go to a very small circle of movers and shakers.